Tag Archives: PMB

Understanding DMS

Disclaimer: This article contains information about investments in cryptocurrency assets. Investments such as these are extremely risky and you should carefully read and understand all aspects of investment and what makes cryptocurrency investments even more risky. Also, the author is an issuer of a cryptocurrency asset and may (or probably does) have vested interests.

So, you’ve become interested in the Deprived Mining Speculation, or DMS, securities have you? DMS.Purchase, DMS.Selling, and DMS.Mining seem to get a lot of attention these days, but can you quickly tell me which asset does what?

Well, you’ll be forgiven for not fully understanding how it all works because this is a very complex set of assets that confuse seasoned investors to no end. Add to the situation that a lot of community participants have very wrong ideas about what these assets do, and you’re pretty close to a guarantee of misunderstanding what you’re actually buying.

Note: Please read the update at the end of the article as it reveals how deceptive these assets can be.

Don’t worry, though, because in this article, I’ll explain it as easy as I can. I’ll take some shortcuts around the math as usual by using some silly numbers, while maintaining the integrity of the idea behind this security. Also, I’m assuming you have a fairly good understanding of what Bitcoin mining is, so I’ll skip the basics of explaining that.

An Executive Overview

DMS is a set of three correlating assets that works most of all like a bet. The three assets are DMS.Purchase, DMS, Selling, and DMS.Mining, and each work as a separate investment opportunity.

The bet is on whether mining investments will ever make money at all. The buyers or holders of DMS.Selling believes mining investments will never make back what their buyers have paid. The buyers or holders of DMS.Mining believes that mining investments will be profitable.

DMS.Purchase is a bit different because it is the entry point of each of these bets. Buyers of DMS.Purchase gets one share of each of DMS.Selling and DMS.Mining and would be smart so sell the share against which they bet.

However, unlike what many people seem to think, though, there’s no Bitcoin mining involved. The confusion stems from the fact that under certain conditions, DMS.Mining may appear to act like a mining bond and people seem to want to compare it to other mining bonds and contracts based on this fact. Doing so, however, is at best a bit naïve and at worst deceptive; there’s no mining involved, simply a dividend payment that mimics that of a bond under certain conditions. In fact, as I’ll show you later, there’s no way you can reap the benefits of being right in your bet on DMS.Mining.

What’s more confusing is that DMS.Selling, which is the bet against DMS.Mining ever making more than 100% return-on-investment, only pays out if the situation is such that DMS.Mining keeps acting like a mining bond. If that situation stops, DMS.Selling won’t get any more money and shortly thereafter DMS.Mining will shut down.

Confused yet? Let me see if I can clarify, one asset at a time.

DMS.Purchase

The DMS.Purchase asset is by far the easiest to explain because it is simply the way new shares are issued onto the market.

The purpose of a DMS.Purchase share is to give you one share of DMS.Selling and one share of DMS.Mining. In other words, the price of DMS.Purchase should always be the sum of one DMS.Mining and one DMS.Selling.

For the sake of the example, and silly numbers, let’s say that DMS.Selling and DMS.Mining both sell for 1BTC each. The price of DMS.Purchase will thus be 2BTC.

You can exchange one DMS.Purchase into one DMS.Mining and one DMS.Selling at any time, and really, this is usually the only thing that makes sense. The funds received will be invested in a very conservative way with just a few investment options being on the approved list. Considering the low-risk returns from investment and the management fee of 3%, the return from holding DMS.Purchase would be lower than simply investing in the underlying investment options directly.

DMS.Purchase receives dividends equivalent to what both DMS.Mining and DMS.Selling gets. However, because the price and thus resale value of DMS.Purchase options are defined by the price of DMS.Mining and DMS.Selling, which in turn is designed to go down as dividends are paid out, the price of DMS.Purchase will not rise.

DMS.Mining

Contrary to what many seem to believe, DMS.Mining is not a mining asset. However, it does represent a bet that Bitcoin mining assets will make money.

The way this bet works is that DMs.Mining pays dividend as if it were a mining bond with 5mhs hashing power, at least based on a formula for what an average of mining output would be, sans transaction fees, miners luck, and pool fees.

Note: This isn’t the same as a 5mhs mining contract or operation. Read more in my comparison of PMB and mining contracts.

The first question you should ask yourself is this; if there is no mining going on, from where do the funds come to pay the dividends?

The answer to this, as I eluded previously, is that the money comes from people buying DMS.Purchase, which may mean you if you got your DMS.Mining shares from swapping in a DMS.Purchase.

This may sound a bit sneaky, but it works as a way to speculate. After all, you pay 2BTC, get one share of DMS.Mining and one share of DMS.Selling. If you want the mining equivalent income, you can just sell your DMS.Selling for 1BTC.

You can, of course, also buy 1 DMS.Mining directly from the market and skip the DMS.Purchase route; the effective price you pay is the same. Regardless of which path you choose, DMS.Purchase has received the funds from someone and those funds will later be used to pay out dividends.

DMS.Selling

So now that we’ve explored DMS.Purchase and DMS.Mining, the rest should be easy, right?

Sorry to disappoint, but there is a major twist on the last leg of our exploration, and that is DMS.Selling.

You see, the entire DMS portfolio is a bet on whether Bitcoin mining assets will ever make money. Those that buy DMS.Selling believe that this will not be the case, so they should get some for of reward if they are correct, right?

Well, they do, and here is how it works.

The dividends paid to DMS.Mining goes down as Bitcoin mining difficulty goes up. That means that the price paid for DMS.Purchase may never be exhausted if the mining difficulty goes far enough up. In other words, if difficulty rises so much that a DMS.Mining share will never get back more than you paid for it plus what someone paid for DMS.Selling, then those excess funds will be paid out as dividends to DMS.Selling share holders.

In theory, this makes payments very difficult because who can say whether DMS.Mining will ever get paid enough to get all the funds paid in? After all, eternity is a very long time.

In practice, DMS solves this by introducing several steps of coverage. This coverage is determined by how many days of DMS.Mining dividends are available.

For DMS.Selling dividends, as long as the funds from sales of DMS.Purchase exceeds 400 days of dividends to DMS.Mining, any excess funds are paid out as dividends to DMS.Selling.

To understand how this calculation works, let’s imagine that 500 people buys DMS.Purchase for 0.4BTC each for a total of 200BTC and the immediately converts those DMS.Purchase shares to DMS.Mining and DMS.Selling shares.

If each DMS.Mining should get 0.001BTC per day, for 400 days, this amounts to a funding requirement of exactly 200BTC (500 shares x 0.001/share x 400 days). Because this is the same amount paid for buying the DMS.Purchase shares, no dividends are paid.

However, if difficulty then rises so that the payments drop by 10% to 0.0009 per day, the funding requirement for DMS.Mining is now just 180BTC. The excess 20BTC are thus paid out to DMS.Selling share holders, for a total dividend of 0.05/share.

The numbers aren’t quite so easy to understand, though, because the funds available obviously goes down as DMS.Mining dividends are paid out. Also, dividends to DMS.Selling won’t be paid out until there is more than 410 days of DMS.Mining dividends available.

In short, however, as long as difficulty goes up and does so by a certain amount, DMS.Selling will get dividends.

Now that we’ve explored the assets, let me explain why this becomes a very tricky investment.

Where’s The Catch?

You may have several questions at this point, and if you don’t, you have either cheated and read the contract already or you’re far smarter than me.

For the rest of us mortals, however, let’s consider some of the consequences of this bet. I’ll also show you why DMS.Mining isn’t a mining asset and is doomed to lose, regardless of whether you are right in betting that the difficulty rise will slow down.

First, what happens if difficulty doesn’t go up or even goes down? After a relatively short time, the 400 days will expire, especially if difficult goes down because this will increase the dividends to DMS.Mining.

Well, if the funds available in DMS.Purchase at any point gets below 100 days worth of dividends to DMS.Mining, all the funds will close immediately and DMS.Mining gets whatever remains in a lump sum payment. In other words, you won’t get any more dividends but you get just over three months of dividends paid out right away.

This may sound generous but there’s a catch. You see, if you buy or keep DMS.Mining, it is likely because you believe mining will be profitable. If DMS.Mining closes, and it would do so because mining has become too profitable, you’ll probably want to move your funds into a different asset.

However, the situation that may make mining profitable is a stop in the rise of mining difficulty. If that happens, all mining assets suddenly becomes vastly more profitable and thus prices will rise rapidly.

At the same time, everyone will know that DMS.Mining will stop operating and pay out a lump sum but will have no chance of reaping the potential huge rewards that a stop in rise or even a drop in mining difficulty will cause.

There’s no reason for anyone to pay more than dividends for whatever time remains until DMS.Mining closes plus 100 days, so prices for DMS.Mining will not rise. Thus, the funds you get from selling or liquidating DMS.Mining will certainly not be enough to buy an equal share of hashing power in a different asset, which by then will have risen dramatically because they can reap rewards from lower difficulty forever.

Let’s run a thought experiment again, where the funds in DMS.Purchase is now 1BTC and only one DMS.Selling and DMS.Mining exists. Dividend payment for DMS.Mining is 0.0025 so the DMS.Purchase funds are enough to secure 400 days of dividends. The price of a DMS.Mining share is 1BTC and a competing asset ACME Mines also cost 1BTC and pays exactly the same dividends.

Then, disaster strikes. Godzilla lays waste to Tokyo and several Chinese cities and takes out 50% of the Bitcoin mining network. This means that the profitability of mining for the remaining network doubles immediately and in a rational market, that would also double the prices. Of course, if ACME Mines is backed by hardware located in Tokyo, the hardware will also be lost, but that is a risk of any hardware based mining.

However, because the funds in DMS.Purchase are limited to 400 days (and now 200 days due to the drop in difficulty) a buyer knows that there is no possible way to get more than 200 days worth of dividends out of a DMS.Mining share. Even if dividends are paid out immediately, the maximum that can be paid is 1BTC.

For ACME Mines, however, the drop in difficulty means that long-term profitability will skyrocket. In fact, the return on investment (ROI) of ACME Mines bought for 1BTC is now 91.25%, which is an insane return for any investment (NASDAQ Composite usually does 4-7% per year).

In two years, someone buying an ACME Mines share will not just have gotten back everything they invest but a healthy 82.5% interest on their investments on top of that, and they can keep reaping that reward until they retire. Prices on shares like that go through the roof and probably double overnight.

Why DMS.Mining Will Always Lose

For DMS.Mining, however, well, there’s no such future. In just three months, the fund will forcibly close and you’d get another three months and a bit worth  of dividends plus probably a pat on the back and a ‘thanks for playing’ from Deprived. You’ll at most get 200 days or just over six months of dividends, representing just 1 BTC.

ACME Mines shares on the other hand, and assuming its hardware is not residing in the bowels of Godzilla, now cost 2BTC. Effectively, you’ve lost 50% of your mining investment even if you were right in your bet.

Note: Keep in mind, I’m using silly numbers to exaggerate the example to show how DMS.Mining is not a mining asset and only behaves that way if you are wrong in your bet on mining profitability.

The idea behind the DMS assets is that DMS.Selling should represent a bet that difficulty will go up and that DMS.Mining should represent a bet that difficulty will not rise by too much. Both assets reward investors who are right. In other words, if you believe mining to be a profitable undertaking, you’ll want to buy DMS.Mining shares.

This is correct, as long as you only consider DMS and not what happens in the rest of the Bitcoin investment world. If you believe in mining profitability and you’re right, you’ll want to reap the rewards.

However, as I’ve just explained, this won’t happen. If you are right, you’ll get a fairly small amount in payment from DMS.Mining and may even be stuck the shares because nobody will want to pay a dollar now for a dollar in the future so you’ll probably need to sell for less than you’ll get in dividends and lump sum over the next months.

Other mining assets will rise, though, so your ability to cash out and earn from being right is limited at best and completely gone at worst.

So, the brutal result is this: If mining difficulty keeps going up, DMS.Mining will lose the bet. However, if mining difficulty goes down or even flattens out, DMS.Mining will also lose the bet. There’s actually no way that DMS.Mining can win this game.

It is very important to understand this catch. DMS.Selling is the only asset that in reality can actually make money in DMS. If DMS were the only assets available in the world, then yes, DMS.Mining could earn money, but in a world where other mining assets exist, the loss in rising prices of those other assets will quickly and brutally cancel out any earnings from DMS.Mining.

So, DMS.Mining is not a mining asset and doesn’t behave like one, except when you are slowly losing money by holding it due to difficulty increases. If difficult slows down, you’ll only lose money faster.

Sounds harsh? Indeed it may be, but now at least you know. You also know why I really don’t consider DMS.Mining a mining asset and thus don’t want to compare it to BFMines.

Update August 10, 2013:

Deprived, the issuer of DMS, was apparently being less than completely honest about the outlook of his assets and in several drunken posts on Bitcointalk admitted that there is no way that DMS.Mining would ever make money and anyone investing in DMS.Mining were idiots. Interestingly, his claim is that there was no way DMS.Mining would make money until now so if you believe him this time, you should definitely run over and buy.

If you believe this article, of course, you wouldn’t.

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Are Perpetual Mining Bonds Scams? Not Really

Disclaimer: I’m getting a bit tired of saying this, but please do not take this as financial advice. Do your own research, make sure you understand what you are buying, the risks and rewards involved, and the factors that affect market pricing.

In a previous article, I explained what mining bonds are, but if you didn’t read that, think of mining bonds as a loan where you, as the investor, lends money to the issuer, and the interest you get in return is defined by some number of hashes of Bitcoin or Litecoin mining.

I posted that article based on a discussion around a certain mining bond PAJKA in which I currently hold a position (that means I own bonds for all you inexperienced investors).

Note: That was my disclaimer about having an explicit interest in PAJKA.

The result of that article was that one investor in particular got a bit of panic, sold of a substantial amount of his bond at whatever price he could get, and went on to claim that all perpetual mining bonds (PMB) are scams.

Well, PMBs are not scams and I’ll tell you why and try to answer the most common questions around why PMB may be a great investment or may be your worst nightmare.

Perpetual Difficult Climb

Perpetual mining bonds yield a fixed and pre-determined return based on a number of hashes per bond. However, if mining difficulty increases, that means the return will diminish. The faster the difficulty increases, the less return the bond will yield.

This may seem like an obvious scam because we all know that difficulty will keep rocketing into the sky forever, right? After all, technology becomes better and more and more people will mine, so the difficulty must go up forever just like the total number of computers on the planet, right?

Well, that’s the first mistake and false assumption.

The difficulty of mining Bitcoins has gone up significantly in the previous few months. This is largely due to the introduction of ASIC mining, a huge leap in technology that renders all other mining equipment significantly less valuable.

Note: To learn more about ASIC mining and why it is so important to Bitcoin, you can read my article “What are ASIC Miners and Why are they So Important?”

ASICs are certain to change Bitcoin mining forever, but it won’t drive difficulty into perpetual rise. The reason, in fact, is that ASICs are just computer chips that are bound by the same limitations that other computer chips are. You can only make them so small and so efficient before you start running into problems of sizes of atoms.

Currently, the most powerful scheduled ASIC miner is developed by Swedish KnCMiner. Their ASICs are built on a 28nm technology. Currently, the best normal CPUs use 20nm technology, and those chips are extremely difficult to make.

ASICs may be simpler devices, but it is still difficult to get much smaller than the 28nm without investing significant money into development. As such, the rapid increase in ASIC efficiency is bound to slow down significantly very shortly.

However, this doesn’t mean that you can’t build more chips. Distribution can easily counter any lack of technological progress, especially in Bitcoin and Litecoin mining where every computer is part of the same network and runs towards the same goals.

Of course, as more and more miners come online, difficulty will keep rising, and pretty quickly, the profitability of mining equipment drops to zero or below. After all, you wouldn’t want to buy an ASIC miner for $10,000 if during its lifetime it would only give you $1,000 back, would you?

So, as more miners come online, the incentive to add more miners will drop, thus reducing the rate of network difficulty increase. At some point, adding more miners will not make sense and network mining difficulty will stop increasing.

The whole Bitcoin network was designed to be marginally profitable to miners. There’s a gold rush right now because ASICs represent so much of an advantage, but sooner or later, they will become unprofitable too.

And guess what; no matter when that happens, you still have your mining bond that will continue generating money. You don’t pay for electricity, you have no risk of hardware failure, you just sit there and watch as your Bitcoin or Litecoin wealth grows.

Note: Some mining bonds have buyback policies that allow the issuer to buy back bonds under certain conditions. carefully read the contract before you buy in and understand the terms under which an issuer can buy back bonds.

Yes, the value and thus return of your bonds will drop as difficulty grows. No, you won’t reap 50% yield per year, but c’mon, any semi-experienced trader knows this is an insane return on any investment. In PMBs, you have virtually no risk. Find a risk-less investment in a traditional market and you’re lucky to get 3-4%.

The reduction in profitability applies to any mining operation, regardless of whether you buy bonds or buy hardware to mine yourself.

Speaking of which…

Buying Hardware is Cheaper!

A second argument against PMBs is that buying the hardware yourself is cheaper than buying a bond. For example, a 1 mh/s bond from TAT.VirtualMine at this time costs around 0.0079. If you buy a 7950 GPU costing around 2BTC, you get 500 mh/s. To get 500mh/s from TAT.VM, you need to buy bonds for almost 4BTC. Clearly it is cheaper to buy a GPU yourself, especially if you have cheap electricity, right?

Well, yes, in cost it is cheaper to buy hardware, but this again is a mistake and false assumption. Let me use a somewhat contrived example to show you why.

It is also cheaper to dig for oil yourself rather than buying shares in Exxon to drill that oil for you. If you buy into Exxon, with some fancy math magic, you get approximately $0.007 dollar per day in dividends. Compare that to the return you would get from drilling your own oil where you get 100% of the profit, or almost $100 per barrel of oil!

Sure, Exxon drills oil on a much larger scale, but c’mon, per barrel you’re getting those $0.007 divided by the roughly 4 billion barrels of oil Exxon mines every day. You’re getting scammed by buying shares in Exxon!

Nobody in their right mind would make such a claim because after decades of experience, society knows that to drill oil, you need a lot of skill, investment in expensive equipment, the knowledge to maintain that equipment, the market in which to trade your product, and so on.

Buying hardware, running, and operating a mine, taking on the risks of equipment failure, ensuring the power and internet connection stays on 24/7, having a heck of a time if you need to leave three weeks on vacation… Operating a mine is hard work! It comes with a lot of risk and burdens, and for some, it is simply not an option.

Add to that the cost of time you need to invest in learning how to operate that mine safely, the time you need for maintenance and optimization, and the risk you have solely on your shoulders if something breaks, and the cost isn’t as cheap as some would like to imagine.

Perpetual Mining Bonds are Never Meant to be Profitable for the Investor!

For obvious reasons, I can’t speak about the intentions of any asset issuer. However, the profitability of perpetual mining bonds are exceedingly easy to calculate. What is difficult is predicting the difficulty of the Bitcoin mining network, and the guesses from various parts of the community ranges from “nah, it’ll never go beyond 200 million” to “it will rise to 1 billion by next week and continue to rise at 100% every day for the rest of eternity”.

Neither of these predictions will likely be correct, but you, as an investor, is tasked with finding the middle ground. This is the research part you need to do. If you believe in perpetual difficulty growth then clearly buying mining bonds is a bad idea. However, if you believe that mining difficulty will stop and decline immediately, then mining bonds will yield incredible results.

For an issuer, however, the reverse is true. If they believe that mining difficulty will continue to rise at incredible speeds, then issuing a mining bond makes sense because it will be very cheap financing. If they believe the difficulty will drop then issuing a bond denominated effectively in that difficulty is a bad idea.

The main difference, however, is that in lieu of a buyback option, a PMB is always going to be a loss to the issuer given enough time. Granted, if difficulty rises enough, the sun may burn out before that becomes a serious issue, but in the end, a mining bond will always return a profit to its owners, albeit a small one.

Let me briefly mention PAJKA again as an example. PAJKA was initially issued in June of 2012, so roughly one year ago. During that time, the bond has paid out its principal (meaning the amount the bonds cost) plus a healthy profit for its owners. Even today, PAJKA returns over 50% at current trading prices, with absolutely no operational risk to its owners.

How would it be possible for the issuer of PAJKA to predict that in a year, difficulty would suddenly get a surge? The simple answer is that it is impossible to know.

If PMBs like PAJKA were scams, it would be the worst scam in the history of mankind, where the scammer ends up giving more money to his victims than they risked. It would be like a bank robber heading into a bank and screaming “THIS IS A ROBBERY! HERE, TAKE THESE $100,000 OR I SHOOT!”

So no, PMBs aren’t scams. If you want to be cynical, they are really bets, where you, as the investor, bets that the difficulty will not rise enough over a long time that your profitability goes away, and the issuer, well, the best interest of the issuer is that difficulty shoots through the roof forever, securing cheap financing of the bond.

But it’s not a scam.

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